The Treasury Market Appears To Have Exhausted The Selloff - Time To Reverse??
2 weeks ago I talk about how US Treasuries were rich vs stocks (ES in particular), and that monthly cyclicals would force treasuries to cheapen vs stocks. On Dec 6 (on my prop model) i read 10yr yields as 14 basis points rich vs stocks. At the time there were 2 reasons why i thought bonds would cheapen. 1) they were rich on the model graph 2) there were auctions coming, and the market likes to get short in front of the auctions. Over the past 2 weeks, treasuries have indeed cheapened (24 bps from peak to trough). (positive on the spread graph = 10yr cheap)
Now with the last auction of the year out of the way, and price action in the treasury market that appears to indicate an exhaustion, combined with additional price action that indicates short covering today, my prediction is that the time has come for treasuries to go back the other way (ie..time to richen vs stocks).
With year and month-end only 7 trading days away (and 2 of those are early closes for the bond market), and 10yr yields reading 6 basis points cheap as of this writing (they reached 10 bps cheap yesterday at the height of the selloff), the higher probability trade is to buy weakness in UST while simultaneously buying stocks..expecting treasuries to outperform. This trade makes no prediction about the direction of the stock market or global risk on / risk off sentiment (when stocks prices go up, we normally expect treasury prices to go down). We are just trying to capture the relative difference between asset classes. December has traditionally been a strong month-end for treasuries. The cyclicals for stocks are less clear..and the fiscal cliff drama makes this even harder to handicap...but the odds say this position should win more often than not, especially from these attractive levels.
The aggressive trade is just to get long US Treasuries...but the relative value trade is to get long both. Like most things in trading, there is no guarantee that this trade will be profitable by year-end...but i'm a betting man, and i'm betting that it will. As always, thoughts about these trades are updated on the blog and twitter...feel free to follow along.
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